Analysis of Economic Principles - Assignment Example

MAE101 Economic Principles Assignment Challenging Version: Algebraic Name: Course Professor’s name University name City, State Date of submission Task 1 Part a For a perfectly competitive market to exist the invisible hand as well as the economic forces work “unimpeded in the market” (Krugman & Obstfeld, 2000; Krugman & Wells, 2006). Mas-Colell additionally, perfectly competitive markets are defined by absence of monopoly power and “universality of markets” .Several features define a perfectly competitive market, and these include the existence of many firms in the market, the production of a homogenous product by all firms in the market, limited barriers of entry and exit into the market, and perfect knowledge by consumers concerning the market and awareness of any changes in the market thereof (Taylor, 2005; Sloman & Sutcliffe, 2002). A review of some of the cold medication available in Australia reveals that there are several manufacturers of these drugs. Among the major players include Johnson & Johnson through their subsidiaries such as McNeil Industries, McNeil consumer Healthcare, and McNeil Laboratories, Boehringer Ingelheim, Reckitt Benckiser, GlaxoSmithKline, and Proctor & Gamble Manufacturing Company (Colander, 2003; Economics Association, 2009). Thus, this market is characteristics of perfect competition, sine while some of these firms are large multinationals, none of them have the market power to determine the prices of cold medications. This market shows evidence of many firms in the market place, an absence of a monopoly, and sale of homogenous cold flu medications. Additionally, there is limited government intervention in this industry signifying the workings of the invisible hand. Much of government efforts have however been directed to the distribution of drugs and mediation as opposed to the manufacturing and pricing (Graves, Jarvis, & Halton, 2009; Eatwell, Milgate, Newman & Palgrave, 2007). Part b There are economies of scale in the cold relief mediation. A wide body of research spanning for over two decades has suggested that the superior performance of large firms (such as GlaxoSmithKline, Johnson & Jonson and Proctor and Gamble) in the pharmaceutical industry is more resultant of economies of scope rather than economies of scale (Lee, 2009; Kindleberger, 2008). According to the authors, economies of scale and scope are vital components of the research and development in pharmaceutical firms and their presence presents significant implications to the total returns. Butler (2005) explain that in drug development, the returns as a result of scope come up when two or more activities become more efficient once they are conducted together. For instance, these firms are able to utilize knowledge produce in one research area into another at no additional cost (zero marginal cost) (Healthcare Financial Management Association, 2002). This is especially so in large firms which in this case have the ability to transfer knowledge on the efficient handling of clinical trials across several research projects in the same firm, which cuts down the cost of these trials as well as their high demand for expertise due to their complexity (Institute Of Cost Analysis, Gulledge & Litteral, 2009). In economic terms, economies of scale can be defined as the cost advantages that a certain business gains as a result of expansion (Folland & Rocco, 2014). According to Princeton, it is based on the premise that the average costs of production per unit (unit costs) decrease as the size of the firm and utilization of other inputs is increase. Owing to the complexity associated with drug development and its multifaceted nature, a firm is able to reduce costs associated to specialized expertise (labor) applicable to a large group of candidates (Rice, 2003). Additionally these authors state that due to the sheer size of these firms, they are able to hire more specialized resources, and specialized software to reduce the overall cost of large scale testing and clinical trials. Part c Total cost spent = 300 Probability of success= 0.5 In case it does not succeed, constant cost is 4 Fixed costs and marginal costs Marginal cost can be define as the change in total cost with every increase in production by one additional unit, whereas fixed costs can be defined as the business expenses often related to time and payable on a monthly basis (Healthcare Forum (Organization), 2007). These include salaries, interest on loans and rent of premises. The fixed costs are those costs that do not change regardless of the units of production produced. Task 2 i) letting f(x1; x2) = ax12 + bx2x1 + c represent a total, then, the marginal of f(x1; x2) is given by 2ax1 + bx2. Applying this formula to the MR (Q1; Q2) = 26- 4Q1- 2Q2, we must find the profit maximization formula in order to verify that Q1=Q2=4. Profit Maximization formula P=MC Assuming Q2=0, MR (Q1; 0) = 26.0- 4Q1-2.0 Therefore, Q1=4 Also, taking Q1=0, MR (0; Q2) = 26.0-0.Q1-2.2 Therefore, Q2=4 ii) Deriving the equilibrium price Equilibrium Price could be achieved by equating, Marginal Revenue= Marginal Costs. That is, MR=MC 2-2Q1=8 Q1=5 2-2Q2=2 P= 26-5Q1 Q2=2 Substituting for Q1 and Q2, 26-20-4=2 Therefore, P.equilibrium= 2 iii) Quantity demanded equals the quantity supplied P=26-5Q1 MC=26-4Q1 Thus Q1=4 Substituting for Q2 yields Q2=4 Therefore, Q1=Q2=4. Thus quantity demanded equal the quantity supplied. iv) The profits of each firm Firm 1 and Firm 2 Profits R1=26-4Q1-2(3Q1-4) R1=26-4Q^2 1-6Q1+8 MR1=26-Q1 Q1=26, Solving for Q2=22.5 Since MR=MC was used as a criterion, P1=26 and P2=22.5 v) Source: Healthcare Forum (Organization), 2007) Task 3 a) Qv = a – b*Pv Qv=30-4Pv, and also Qv=5-Pv Pv=30/4-Qv/4 or Pv=5-Qv Solving for PV, 7.5-0.25Qv=5-Qv 2.5=-0.75Qv Qv=3.33 b) Profit maximizing output If firm 1 were successful in a monopolistic market, it would produce so as to cover the whole market share and thus annihilating firm 2. Thus, TR1=p.q TR=15*3.33Qv = 50Qv MR=50 Profit maximizing output MR=MC 50=Qv + 10 Qv=40 c) TR=15*3.33Qv = 50Qv TR=50Qv* 0.5-300 TR= 50*3.33*p (0.5)-300 =166.5*p (0.5)-300 d) If firm 1 develops the vaccine, the firm would consider on production of the cold relief including the firm 2. The reason is that the vaccine threatens to eliminate the market for the cold relief medication by making it irrelevant in the face of the vaccine. Since the vaccine is only used once, this would reduce the firm 1 profit in the long term since there would be no dependence of the medication. Hence, both firms would continue to produce the cold relief medication (Baumol & Blinder, 2009). Task 4 a) The pharmaceutical firms are economic agents who take the best interests in themselves. Therefore, developing medications that would not cure the diseases such as cold will be of ultimate benefit for the firms as they continue to reap profits overtime. Developing of antibiotics is expensive and would only serve to take them out of the business reducing their market, profitability and the long term growth. The development of an antibiotic is a public good since its development would serve to improve the welfare of the public since it encompasses with it a spillover effect (Institute Of Cost Analysis, Gulledge & Litteral, 2009). b) Diseases like Ebola are exceedingly rare disease but are rather severe in terms of the consequences as it is fatal. Such a disease has not yet found a cure. The reason is that the demand for such a drug is very low as such cases are seasonal and are rather quarantined in the area of emergence thus avoiding more fatalities and spread. On the other hand, the costs of researching for such a deadly viral vaccine are very high as compared to the benefits attached to its commercialization. Thus, since the costs far exceed the gains from such a venture, private individuals and firms find it difficult to invest in such an undertaking (Institute of Cost analysis et al., 2009). References Arnold, R. A. (2001). Economics. Cincinnati, Ohio, South-Western College Pub. Baumol, W. J., & Blinder, A. S. (2009). Economics, Principles, And Policy. New York, Harcourt Brace Jovanovich. Butler, J. R. G. (2005). Hospital Cost Analysis. Dordrecht, Netherlands, Kluwer Academic. Colander, D. C. (2003). Economics. Homewood, Il, Irwin. Eatwell, J., Milgate, M., Newman, P., & Palgrave, R. H. I. (2007). The New Palgrave: A Dictionary Of Economics. London, Macmillan. Economics Association. (2009). Economics. West Sussex, Etc, Economics Association]. Folland, S., & Rocco, L. (2014). The Economics Of Social Capital And Health: A Conceptual And Empirical Roadmap. Graves, N., Jarvis, W. R., & Halton, K. (2009). Economics And Preventing Healthcare Acquired Infection. New York, Springer.  Healthcare Financial Management Association (U.S.). (2002). Healthcare Financial Management. [Oak Brook, Ill.], The Association.  Healthcare Forum (Organization). (2007). The Healthcare Forum Journal. San Francisco, Ca, Healthcare Forum. Institute Of Cost Analysis, Gulledge, T. R., & Litteral, L. A. (2009). Cost Analysis Applications Of Economics And Operations Research: Proceedings Of The Institute Of Cost Analysis National Conference, Washington, D.C., July 5-7, 1989. Berlin, Springer-Verlag. Jackson, D. (2012). Healthcare Economics Made Easy. Banbury, Scion Publishing.  Kindleberger, C. P. (2008). International Economics. Homewood, Ill, R.D. Irwin. Krugman, P. R., & Obstfeld, M. (2000). International Economics: Theory And Policy. Reading Mass, Addison-Wesley. Krugman, P. R., & Wells, R. (2006). Economics. New York, Worth Publishers. Lee, R. H. (2009). Economics For Healthcare Managers. Chicago, Health Administration Press.  Rice, T. H. (2003). The Economics Of Health Reconsidered. Chicago, Health Administration Press.  Sloman, J., & Sutcliffe, M. (2002). Economics. Harlow, England, Prentice Hall/Financial Times. Taylor, J. B. (2005). Economics. Boston, Houghton Mifflin. Read More